Pre-incorporation deals come with risks: Horst

People who put down a deposit for a property on behalf of a company that is not yet incorporated could lose that money if the buyer pulls out of the deal, says Toronto corporate lawyer Marlin Horst.

Horst, partner with Shibley Righton LLP, cites a recent Ontario Court of Appeal case where a man signed an Agreement of Purchase and Sale for three Toronto properties, stipulating that he was signing as a buyer “in trust for a company to be incorporated without any personal liabilities.”

He provided a deposit of $100,000 to secure the purchase, court documents state, but months later he advised the seller that he wanted out of the deal, and requested to have his deposit returned.

When the seller refused, the man sued, the judgment states, and the appeal court judge agreed with a lower court decision that the deposit should be forfeited.

“There is a law of deposits, which is separate from what Ontario's Business Corporations Act (OBCA) says about pre-incorporation contracts,” he says.

Horst says the seminal authority on the nature of a deposit is an 1884 decision by the Court of Appeal in England. After referencing Roman law, the judge at that time stated that a deposit was “not merely a part payment, but is then also an earnest to bind the bargain so entered into, and creates by the fear of its forfeiture a motive in the payer to perform the rest of the contract.”

Under the OBCA, Horst says a contract entered into prior to incorporation is personal to the party who enters into the deal until that firm is incorporated, and the new entity assumes the responsibility.

“In this case, it appears the purchaser never incorporated the company and essentially walked away from the transaction,” says Horst.

“There’s a long line of cases that says a deposit stands to secure the performance by the party giving the deposit under the contract unless the contract says something else,” he says.

Horst says it is unrealistic to expect a contract to state that the deposit will be returned if the deal doesn’t go through for any reason.

“No vendor would agree to that,” he says, “though many contracts do stipulate the deposit will be returned because of A, B, C or D, with the agreement spelling out exactly what those conditions are.”

The judgment states that the man putting down the deposit thought his money was protected since he was signing as a buyer “in trust for a company to be incorporated without any personal liabilities.”

Horst says that wording protects the buyer from any damages incurred by the vendor because the deal didn’t go through, but that protection does not apply to the deposit.

“The court is saying the vendor could not go after the purchaser for anything in excess of the deposit when it became clear the purchase was not taking on that contract, but the deposit remains separate from that,” he says.

Horst says this judgment could be a wake-up call for people who aren’t really familiar with the law on deposits.

“There hasn’t been a case specifically about something like this for a very long time,” he says, “and I’m not sure of any other case that dealt with the interplay of s. 21 of the OBCA and the law of deposits.”

The judgment states that the section of the Act allows somebody to enter into an agreement without liability for the contract.

It reads, “If expressly so provided in the oral or written contract ... a person who purported to act in the name of or on behalf of the corporation before it came into existence is not in any event bound by the contract or entitled to the benefits thereof.”

The court referenced the section, noting “the provisions of the OBCA addressing pre-incorporation contracts do not displace the common law rules governing deposits in real estate transactions.”